Maturely Accepting Volatility

To find out what India’ leading Chief Investment Officers think about the future of the stock markets and how your investments will fare, we invited nine of them to a roundtable discussion. The topic was ‘The India Story: On Hold for How Long’, but the discussion ranged widely over topics of interest to investors. Here’s an insight into how our leading fund managers are looking at your investments’ future and the factors that will drive it.

Any sectors that need to be emphasized?
Prashant JainTo my mind, banks in India are very cheap. Some banks are available near Book Value and are growing at 15-20 per cent. I do not think there is a systemic risk and there is reasonable value there. I respect the opinions of few of my peers in terms of public and private sector banks. But, on an average, the public companies have probably delivered better financial performance than the private companies.

We are looking at a select universe, where you are ignoring the mortality of the public sector companies
Prashant JainThere is mortality in the private sector too. If you look at the Sensex around two decades ago, you will find that many of those companies do not exist.
Bhupinder SethiWith regards to public and private companies, I would like to say that investing is different from looking at a business in isolation. When one invests, the element of valuations comes into play. It is possible to make money in a public sector company if bought when valuations were very low. Those public sector companies which are open to private sector competition, where there is no moat for them, they find it difficult to compete. You can see it in Aviation and Telephony. But in Banking, where the trust is very embedded and the sovereign backing helps, the public sector banks have a moat. So PSUs that have a moat that cannot be easily replicated by private companies would definitely be in our universe.
Gopal AgrawalThere is a lot of global uncertainty and there will be periodic liquidity squeezes across the globe. Given this backdrop we would not want to invest in a company with very high debt. Interest rates may have peaked but will not see any material downside to the interest rates in India. The global markets are tight and I am not of the opinion that oil will fall materially. So I will invest in companies which have very strong cash flows and which need less capital for future growth. We will continue to focus on Consumption and Outsourcing and certain companies even in Infrastructure and Construction but will stick to those with strong balance sheets. Because in the times to come, inflation will not come down materially.

Bhupinder SethiThe way we look at the market is that there is a qualitative set of businesses, companies which have compounding characteristics, innate strengths in various areas, companies with superior capital efficiency and so on and so forth. These would form the core portfolio. Then there are the quantitative screens in terms of valuations. So even if the business is not too superior, it may make a good purchase at a certain valuation. This would be another set of companies that we would look at. So we would look at companies where the business would drive the stock market return, these would form the core of the portfolio. Then we would also look at trading plays which one would enter because valuations are favourable.

Jayesh GandhiWe broadly divide the equity universe into two parts; domestic and global cyclicals. We are positioning our portfolios based on the assumption that domestic cyclicals will perform much better than global cyclicals for the medium term going forward. We are slightly overweight on Banks and have a fairly large overweight on Consumer Discretionary.
Regarding stock analysis, the balance sheet has become a very important parameter to look at. I believe that investors now look at the balance sheet first and then the P&L. People will pay a premium for quality. By quality, I mean stability of earnings and cash flows and earnings growth; operating cash flows play an important role.
My sense is that assuming we do not get a large tail risk event in Europe, we may be close to the bottom and over the next 12-18 months the upside could be around 15 per cent in line with earnings growth. In a stable global economic environment a 7 per cent real India GDP growth gives us 10-15 per cent corporate earnings growth. It is my calculated guess that this is probably what investors should expect in terms of equity returns. We are in a volatile environment so volatility cannot be excluded.

Sankaren NarenIn 2007, people were bullish on infrastructure. Now people are bullish on consumption. In 2007, people said balance sheets are not important, now they are saying it is all important. These cycles go to extremes so one must keep that in mind when taking a position for the long term. People are getting too obsessed with what is happening in Greece, Ireland and everywhere in the world. It is essential for us not to forget that we are investing in India and in Indian companies. So while we do keep the global factors in the background, our focus has to be on corporates in India and the macro situation in this country.

Anoop BhaskarIn March 2009 we were holding 25 per cent cash. The very next month we found ourselves at the bottom of the pile when the market picked up. Today we are at 7-9 per cent cash. We are doing reasonable well and are close to a tipping point as we were in March 2009. So our biggest concern is that we do not want to miss out on the upside again.
I get very worried when these themes and fads come out, whether its education or whatever, and statements that in 10 years the company will be 15x its current size. I do not want to get into a trap of this or that theme looks good for the next five years or so.
We buy a company for valuations. So if there is something cheap and the management is not very honorable but you have an ability to make money on that holding, then it would justify a buy. The focus is on valuations and risk-reward. So if you are to buy a company which is bad in terms of corporate governance but is available at .25x PB, then you can buy it. On the other hand, there could be a company which is exceptionally good but it is at 7x PB, then it would be wise to sell at least a part of the holdings at that point in time.

How do you deal with steep market declines like those that have very recently happened?

Sankaren NarenInvestors are getting used to volatility. I have been surprised to see people give us money when the market falls and pull it out when it rallies. This shows that they have also realized that volatility is inherently a part of the equity market and they have started to play it for their benefit. This is very good for the mutual fund industry. If the market falls by 600-700 points, the kind of questions I get is should I put in more money? There are day traders with broking firms, people who trade derivatives with broking firms - they are the people who panic with volatility. The mutual fund investor, and I hope this trend continues, does not get spooked by volatility.

Gopal AgrawalEvery time the market falls, investors want to know if they should put in more money. Yesterday I had a meeting with investors and distributors and I could not see anyone worried. They were asking me about the downside I had in mind so that they could increase their exposure.
Most people missed the rally of 2009 so they don’t want that to happen again. They are more comfortable with volatility.

Prashant JainPeople have understood that equity is volatile over the short term but over the long term it delivers reasonably high returns. On dips we find no redemptions, but inflows. The maximum redemptions take place when the index moves to fairly high levels.
In India, what is the collective ownership of Indian stock markets? All households put together could be around $150-200 billion - I don’t really know. But if you look at household assets, it would be 2-3 per cent. If I invest Rs 2 of my wealth in equity, I do not think it will make me unduly worried. The average investor has got used to volatility because he is quite underexposed to this asset class.
Short term in markets is very difficult to forecast and I have never really been successful in trying to time the market. But I still feel that the Indian market is co-related with equity global markets only over the short term. There is no long-term co-relation of Sensex returns with other markets or of economic growth in India with world economic growth. But in times of panic there is a co-relation in equity markets. Panic does not last for years, just weeks or months.

Mahesh PatilLooking at the movement of Indian equities, by mid-2007 the Sensex was at 15,000-16,000. Since then we have not achieved that much. The last four year returns are 5-6 per cent CAGR. Between 2003-04 and 2007-08, there was such a great growth in profits that valuations went up. But since then the market has consolidated in a rage. It did go to 21,000 but came down. It went down to 8,000 but went up.
Over the past 3-4 years profits have grown but valuations have come down from what they were in 2007. We have seen a time correction to a lower expectation of growth in corporate profits. Somewhere in the future we will break out of this trend and move into the next orbit, assuming growth is at least 14-15 per cent.

Bhupinder SethiIn FY07, we were a $1 trillion economy and in FY12 will be a $2 trillion economy. Size of GDP has doubled. Company sales, profits for various sectors would have doubled. So there is comfort in valuations in a lot of areas. If we stay focused on companies which can capitalize on growth we will create wealth. Your investment returns have no co-relation with the sentiment in the market. In fact, it is countercyclical. When sentiment is good, one does not tend to make much money. When sentiment is down and out and you invest in those times, you tend to make money.